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Monday, December 8, 2008

On Friday, April 18th, 2008, the Shanghai Composite Index, China’s main stock market index, dropped nearly 4% to hit a 12-month low of 3,095. Despite tremendous gains in the past couple of years, this “Black Friday” was not altogether unexpected; in fact, China’s stock market, currently one of the five largest stock markets in the world, has taken quite a hit in the past year or so, as the government tried to prevent overheating by cooling inflation and growth. What are the implications of this recent decline in the stock market and what is in China’s future?

To fully understand the recent news surrounding China’s stock market crisis, one must first gain an understanding of the way stocks work in China. Equities traded in China can be categorized into three distinct types: A shares, B shares, and H shares. A shares are yuan-denominated and unavailable to most foreign investors, while B and H shares are both dollar-denominated and available to most foreign investors. In addition, A and B shares are traded on the Shanghai Exchange, while H shares are traded on the Hong Kong Exchange. Oftentimes, a company may sell both A shares and H shares; although both stocks may originate from the same company, there may often be large price discrepancies between the two types of shares.

In the two years leading up to 2007, China’s stock market surged nearly sixfold, making it one of the fastest growing stock markets in the world. As its emerging economy continued to grow at a rapid pace, Chinese citizens were eager to invest their money in the stock market, hoping to quickly double or even triple their initial investments. For a while, this strategy proved highly effective, as the stock market continued to shoot up like a rocket. After the Shanghai Composite Index hit its record peak in October of 2007, it seemed like the good times might never end.

However, in recent times, inflation in China has reached near its highest point in the last decade. In order to combat serious concerns of rampant inflation and economic overheating, the Chinese government has tried tightening monetary policy by raising interest rates. Unfortunately, these actions may have had an overall negative impact on the economy, as the government’s efforts to curb inflation have resulted in slowed economic growth and disappointing corporate profits.

As the stocks prices of many of China’s largest companies have dropped, so has the stock market as a whole. For instance, PetroChina, the largest company in China, saw its stock price fall nearly 5% to around 16 yuan, well below the price at which it was initially floated last October. Similarly, the stock prices of some of China’s other largest companies, such as China Life and Sinopec, have also dropped significantly following disappointing earnings reports. Even with the government passing measures aimed at stimulating the economy, such as tripling the amount of money overseas institutions could invest in yuan-denominated stocks and bonds to $30 billion and ending a freeze on the sale of new mutual funds, the stock market continued to drop. Overall, the benchmark CSI 300, which measures shares traded in both Shanghai and Shenzhen, and the Shanghai Composite Index, which includes 862 company listings, have both declined approximately 40% over the course of the past year, making China’s stock market one of the world’s worst performers during this time period. To put things in perspective, the Shanghai Composite Index is currently 50% below its record high in October 2007.

In the days following China’s “Black Friday,” the government has tried to fight the drastic decline in the stock market, which wiped out $1.7 trillion of market value, by cutting the equity trading tax from 0.3% to 0.1%. The following week, the stock market seemed to rebound, as it gained 16% on the week; this included the biggest single-day gain, 9.2%, in its history. Even though the month of April has resulted in an overall gain for China’s stock market, it is still experiencing some major difficulties.

So what can be expected of China’s stock market in the upcoming months? According to some analysts, such as Jerry Lou and Allen Gui of Morgan Stanley, corporate earnings growth may continue to disappoint this year. Furthermore, in the opinion of Credit Suisse analyst Vincent Chan, H shares are considered more attractive than A shares. At the same time, the recession in the United States may also have a negative impact on China, as the country’s exports may decrease. As a result, the current consensus among many analysts is that China’s shares are viewed as a “sell”.

Nevertheless, there are still reasons for hope and optimism in the coming months. The upcoming 2008 Summer Olympics in Beijing are expected to be a major boom for the economy. As the world’s best athletes descend upon Beijing to compete for Olympic gold, money will also pour into China. Through corporate sponsors, ticket sales, merchandise sales, tourism, and other revenue streams, the Games are expected to bring in billions of dollars to help China’s currently sagging economy. As a result, there are hopes that this boost to the economy will lead to a strong stock market rally once the Games have ended.

Like any country’s stock market, China’s stock market has experienced both highs and lows in the past few years. At present, it is experiencing one of its low points, but moving forward, there may be hope for an improved economy and stock market.